December market update and investment risks

The following reflects the general views of our Treasury & Investment Office (T&IO) and should not be taken as a recommendation or advice as how any specific market is likely to perform.

These views are as at the end of December 2023.

The value of investments can go down as well as up. Investors could get back less than they put in.

Please remember that past performance is not a reliable indication of the future performance.

Overview

Inflation steadily declined in the fourth quarter, following a year dominated by tight monetary policy. In the UK, headline inflation slowed to a two-year low, falling to an annualised rate of 3.9% in November. In the US, the Consumer Price Index rose 3.1% on an annual basis in November. The eurozone also reported a drop in inflation, with annualised inflation reaching 2.4% in November.

Major central banks maintained a halt on rate hikes. The Federal Reserve kept rates unchanged at the current range of 5.25%-5.50%, while revealing that policymakers expected three rate cuts next year. The Bank of England held interest rates at 5.25%, while outlining a gradual decline to 4.25% by the end of 2026. The European Central Bank also preserved its key rate at 4%.

The trajectory of economies continued to diverge in the quarter. With a strong labour market supporting consumer spending, the US economy grew at its fastest pace in nearly two years between July and September. Over the same time period, however, both the eurozone and UK economies contracted by 0.1%, fuelling concerns over recession as consumer spending and manufacturing activity continue to stagnate. Meanwhile, Japan’s economy shrank from the previous quarter,  amid weak demand and high inflation. In emerging markets, China’s economy expanded with exports growing for the first time in six months. Overall, global economic growth, despite demonstrating resilience this year, remains subdued and is expected to weaken in the year ahead, amid an environment of tight monetary policy, inflation and geopolitical tensions.

Equities (or shares)

The UK stockmarket ended 2023 on a positive note. However, it was one of the weaker regions globally, trailing the US and Europe, over concerns about its subdued economy. Inflation fell to 3.9% in November and expectations that the Bank of England might cut interest rates in 2024 helped shares climb from late October. Real estate and utilities registered healthy gains. Industrials and information technology also rallied.

US equities ended the year with a powerful rally. After declines in October, share prices soared as investors become optimistic that the Federal Reserve had ended its interest rate hiking cycle. With annual inflation falling and the economy remaining resilient, the S&P 500 Index climbed towards all-time highs.

European equities rallied as hopes of interest rate cuts lifted sentiment. Europe was one of the best-performing regions globally and the gains helped European shares deliver an annual return of around 18% (in euro terms).

The Japanese stockmarket rallied strongly from late October but over the quarter, lagged other markets

What do you mean by Equities?

  • Equities are commonly known as "shares". When a fund buys a company share, it is investing in a company and, in exchange, receives a share of the ownership of that company. Shares give two potential investment benefits:

    • share prices may increase as the value of the company increases.

    • companies may pay dividends - regular payments made to shareholders based on how well the company is doing.

What are the general risks of this type of asset? 

  • Over the longer-term (over 10 years), equities are considered to offer greater growth potential than many other asset types. However, the value of any investment can go down as well as up and so there is a higher risk of losing your original capital than investing in fixed interest securities (see below).
  • The financial results of other companies and general stock market and economic conditions can all affect a company's share price, and consequently the value of any fund investing in that company.

Fixed interest

UK government bonds (gilts) returned 8.1%, outperforming both US government bonds (Treasuries) and German government bonds (bunds). Gilts were supported by increased expectations of interest rate cuts by the Bank of England, as annual inflation eased to 3.9% in November; the market is pricing in six cuts for 2024.

Global bond markets avoided a third consecutive year of losses as the quarter saw a two-month rally in bond prices driven by increased expectations of interest rate cuts by major central banks in 2024. Bond yields fluctuated throughout – the US 10-year Treasury yield reached 5.0% in October, its highest level since 2007, before retreating on the back of falling inflation figures and the prospect of interest rate cuts.

UK corporate bonds also rose, returning 7.3% in the fourth quarter.

What do you mean by Fixed Interest?

  • Fixed interest securities, more commonly known as "bonds", are loans issued by companies or by governments in order to raise money.

  • Bonds issued by companies are called Corporate Bonds, those issued by the UK government are often called Gilts or UK Government bonds and those issued by the US government are called Treasury Bonds.

  • In effect, all bonds are IOUs that promise to pay you a sum on a specified date and pay a fixed rate of interest along the way.

  • Index-linked securities are similar but the interest payments and redemption value are normally increased by a price index e.g. for UK government index-linked securities, interest payments and redemption value are increased in line with the UK Retail Price Index.

What are the general risks of this type of asset

  • On the whole, investing in Government or Corporate Bonds is seen as lower-risk than investing in equities. To date, no UK government has ever failed to pay back money owed to investors. But with Corporate Bonds there is a risk that the company may not be able to repay its loan or that it may default on its interest payments.

  • Corporate and Government bonds are sensitive to interest rate trends. An increase in interest rates is likely to reduce their value, and hence the value of any fund investing in them.

Property

Declines in capital values of UK commercial property accelerated in the three months to November (the latest month for which data is available). According to property consultant CBRE, prices fell by 2.0%. Performance over the period was most challenging in the Office and Retail sectors. In the Retail sector, sizeable falls in capital values were seen across each of the sub-sectors – retail warehouses, standard shops and shopping centres. Capital values in the Industrial sector were broadly flat. Rental value growth was strongest in Industrials, although some growth was seen in Offices and Retail as well. UK government bond yields have fallen sharply (and prices risen) since the end of October, which may provide some support for commercial property values going forwards.

What do you mean by Property?

  • For our funds we would mean commercial property investment. This generally means the fund is sharing in the returns from the ownership of some buildings (for example, offices and shopping centres).

  • The value of the property may increase and tenants may pay rent to the owners of the building.

What are the general risks of this type of asset

  • Property can be difficult to buy and sell quickly. Fund managers may have to delay withdrawal of money by customers from a property fund until they can sell some of the buildings the fund invests in.

  • The actual value of a property is what someone is prepared to pay for it - an actual sale value. As sales are infrequent, interim valuations are based on a valuer's opinion and may be revised up or down from time to time. This can affect the value of a fund invested in commercial property, with the value possibly fluctuating significantly and could result in an investor not getting back the amount they originally invested.

  • This leads to a number of risks for funds investing in property:

    • Cash could remain uninvested as property assets can be difficult to buy, leading to lower returns than expected.
       
    • The value of the fund may be reduced if a large number of withdrawals are requested and it is necessary for properties to be sold at reduced prices.

    • There may be delays removing your money from the fund if property cannot be sold.

    • Property fund valuations may be revised periodically, upwards or downwards.

    • Rental income is not guaranteed. Defaulted rent and unoccupied properties could reduce returns.

    • If the size of the fund falls significantly, the fund may have to hold fewer properties, and this reduced diversification may lead to an increase in risk.

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